Just when things couldn't be more challenging for California's budget, we are discovering that the shortfall in three major public employee pension funds (CalPERS, CalSTRS and the UC Retirement System) is far worse than expected. According to our analysis, these three funds face a $500 billion shortfall, about six times this year's state budget.

As members of the generation that must face this fiscal burden, we urge that this not become a political tug of war between liberals and conservatives. Instead, the discussion should center on building a sustainable retirement system that honors our commitment to state retirees, but also sets our state on a path to long-term financial stability.

State law affirms that pension benefits are a form of deferred compensation and must be paid. In short, the debts owed to retired state workers are no different from state general obligation debt.

Why does that matter? Retirement funds discount the value of their future liabilities at the expected rate of investment returns (e.g., 7.75 percent for CalPERS). That accounting gimmick grossly understates future liabilities because payments to retirees are guaranteed.

Instead, sound accounting and economic principles require that future liabilities be discounted at what we call a "risk-free" rate, similar to a long-term U.S. Treasury bond.

Using that risk-free rate, combined with the recent market decline, we estimate that California's three largest pension funds face a shortfall of approximately $500 billion.

Our research team also discovered that understating liabilities is only one element of a broader accounting and fund management problem. Public employee pension funds project an expected rate of return on investments, but downplay market volatility and uncertainty.

That means that funds ignore the wide range of possible investment outcomes, including outcomes when investments underperform expectations. For instance, we discovered - irrespective of how we discount future liabilities - that there is a 44 percent chance that CalPERS will be at least $250 billion underwater in the next 16 years. That means the money has to come from somewhere.

Solutions to this mounting crisis require that more money be injected into pension funds today and that funds invest in less risky assets. Contributions should also be made to pension funds on a steady basis, unlike in the past when payments were allowed fluctuate with market conditions.

And despite much opposition, the state should implement a 401(k)-style retirement system for its future hires, which takes the state taxpayers off the hook if the pension funds don't perform well enough to cover promised payouts.

This predicament will not go away; in fact, it will worsen over time unless proactive change begins now. It is a significant problem for taxpayers and state residents, who will see services decline as the state is forced to cover increased pension obligations. We urge fiscal realism and a productive debate focused on implementing the difficult changes, not the politics we can no longer afford.